Flexible Solutions International Inc (FSI) Q4 2021 Earnings Call Transcript

Good day, everyone, and welcome to today’s Flexible Solutions International Full Year 2021 Financials Call. At this time, all participants are in a listen-only mode. Later, you will have an opportunity to ask questions during the question-and-answer session. Please also note that this call may be recorded. It is now my pleasure to turn today’s program over to Mr. Dan O’Brien. Sir, please begin.

Good morning. This is Dan O’Brien, CEO of Flexible Solutions. Safe Harbor provision: Private Securities Litigation Reform Act of 1995 provides a Safe Harbor for forward-looking statements. Certain of the statements contained herein, which are not historical facts, are forward-looking statements with respect to events, the occurrence of which involves risks and uncertainties. These forward-looking statements may be impacted, either positively or negatively by various factors. Information concerning potential factors that could affect the company is detailed from time-to-time in the company’s reports filed with the Securities and Exchange Commission. Welcome to the full year conference call for 2021. Before discussing our financials, I’d like to update our company condition and our product lines, along with what, in our opinion, might occur in early 2022. COVID virus: The NanoChem subsidiary, the ENP subsidiary and the Florida LLC investments are all engaged in racing for the agriculture and/or the cleaning product sector. Therefore, we’re considered essential services and are likely to remain so even if restrictions are. Virtually all our employees are fully vaccinated. COVID will have effects on our supply chains out of Asia that may cause delays from time to time. Our NanoChem division: NCS represents more than half the revenue of FSI. This division makes thermal polyaspartic acid, called TPA for short. It’s a biodegradable polymer with many valuable uses. NCS also manufactures SUN 27 and N Savr 30, which are used to reduce nitrogen fertilizer loss from soil. TPA is used in agriculture to significantly increase crop yield. It acts by slowing crystal growth between fertilizer ions and other items in the soil, bolting in the fertilizer remaining available longer for plants to use. TPA is also a biodegradable way of treating oilfield water to prevent pipes from plugging with mineral scale. TPA’s effect is that it prevents the scaling out of minerals that are part of the water fraction of oil as it exits the rock formation. The scale must be prevented to keep the oil recovery pipes from clogging. SUN 27 and N Savr 30 are nitrogen conservation products. Nitrogen is a critical fertilizer that can be lost through bacterial breakdown, evaporation and soil run-off. SUN 27 is used to conserve nitrogen from attack by soil bacteria, while N Savr 30 is directed towards reducing nitrogen loss through leaching and evaporation. ENP division: ENP represents most of our other revenue. ENP is focused on sales into the greenhouse, turf and golf markets, while our NCS sales are into row crop agriculture. Q4 was strong as we hoped. Q1 has started well, and we expect similar growth in 2022 as was experienced in 2021. Our Florida LLC investment: Once again, this investment was profitable for the full year. The company is focused on international sales into multiple countries, all of which are facing different issues and responding in varied ways. Q4 2021 was less than hoped for. However, we’ve seen a very strong rebound in ‘22. Indications are the growth by the LLC in the 30% range is possible for 2022. Our strategic investment in Lygos: In December 2020, FSI invested $500,000 in Lygos in return for equity. We made a second investment of $500,000 in June 2021. Lygos is using the investment to complete development of a microbial route to aspartic acid using corn sugar as a feedstock. FSI would be the major user of aspartic acid derived this way and believes that sustainable aspartic acid would allow us to obtain large new customers and develop valuable new products. Lygos’ scientific team have already successfully developed other organic assets and cannabinoids from sustainable feedstock and are recognized as one of the world leaders in synthetic biology by their peers in industry and academia. We have very high confidence in their ability to achieve sustainable aspartic acid through fermentation. Once the economic microbial route is fully developed, we plan to work with Lygos to build capacity to produce aspartic acid, then polymerize into sustainable polyaspartates. Q1 and 2 in 2022: TPA, SUN 27, N Savr 30 for agricultural use have peak uptake in Q1 and Q2. This year is somewhat different due to high crop and fertilizer prices. We’re seeing increased interest in our products and stronger ordering. Maintaining inventory to service customers will be key to maximizing sales. And as one would expect, shipping delays are not helping. To date, our preordering of inventory has made sure that no sales have been lost. Oil, gas and industrial sales of TPA experienced increased sales in late Q4 ‘21 and on into ‘22. This is driven by shortfalls of competing products and high oil prices. Likely to continue through the first half of ‘22, don’t consider it a permanent effect at this time. Tariffs: Since September 30, 2018, several of our raw materials imported from China have included a 10% additional tariff, which then rose to 25% in ‘19. U.S. customers received price increases from us as this inventory entered production. International customers are not charged with tariffs, because we’ve applied for the export rebates available to recover the tariffs. Accumulating tariff payments to government are affecting our cost of goods, our cash flow and our profits negatively so we get the rebates back. It’s going to take many months. It’s now been almost 4 years, 4 years in September. We submitted our completed applications more than 3.5 years ago. The total dollar amount due back to us is well over $1 million, and it continues. Rebates will increase profitability and cash flow while decreasing cost of goods for future quarters when rebates are received. We learned 5 months ago that our application is sent to a government lab so that our formula-based calculations can be verified. There is still no timeframe available for completion. Shipping and inventory: Ocean shipping from Asia to the U.S. and ocean shipments from U.S. to international ports continue to take much longer. Prices per container are more than triple the normal. Land transport inside the U.S. is taking much longer than usual and pricing is extremely high there. We’re doing our best to cope with shipping issues by ordering far ahead. But be warned that some disruption will be unavoidable, and some of the extra costs will be borne by us in order to retain customers. Raw material prices have also increased substantially over the last 6 months. Passing price increases along to customers takes several months and results in temporarily constrained margins. Large proportion of these adjustments were begun in late Q4 2021 and not completed until early March this year. Our Q4 profits show the effect of raw material costs advancing far quicker than selling prices can be revised. This effect will be less visible in Q1 2022, still present, while we expect profits to return to normal levels for the rest of ‘22. We expect revenue, operating cash flow and profit to grow as fast or faster than it did. Highlights of the financial results: We’re very pleased with the results for 2021. Revenue, profits and operating cash flow are all up significantly. These results were achieved in a year when shipping costs were double the crop prices. Raw material prices increased to a significant extent. It’s due to the skill and hard work of the whole FSI team. Throughout 2021, we engaged with new prospective customers and introduced additional products to our existing customers. We anticipate that much of this preparation will result in new sales in 2022. We estimate that we will exceed last year’s growth rate in all the above metrics for the coming year. Sales for the year increased 10% to $34.4 million compared with $31.4 million. Increased sales are mostly the result of new business. It’s a small proportion of price increases. Profits: The result was a profit of $3.45 million or $0.28 a share in 2021, up 16% from a gain of $2.98 million or $0.24 share in 2020. Operating cash flow: This non-GAAP number is useful to show our progress with noncash items removed for clarity. For 2021, it was $5.65 million, $0.46 a share, up 24% from $4.5 million or $0.37 per share in the 2020. Long-term debt: We continue to pay down our long-term debt according to the terms of loans. Working capital: It’s adequate for all our purposes, and it’s increasing continuously as we book retained profit from sales. We also have lines of credit with Midland States Bank for the ENP and NCS subsidiaries. We’re confident that we can execute our plans with our existing capital. The equity investment in Lygos was made with cash on hand through FSL, our Canadian operation. The text of this speech will be available as an 8-K filing on www.sec.gov by Monday, April 4 and request e-mail or fax copies from Jason Bloom at jason@flexiblesolutions.com. Thank you. The floor is open for questions.

And our first question will come from William Gregozeski.

Hey, Dan. I’ve got a handful of questions for you. In regards to the Florida LLC, you mentioned the fourth quarter wasn’t what you expected and it should kind of get back to normal. Is there some isolated event in the fourth quarter? And should we expect kind of the margins to go back to normal for all of ‘22?

Thanks, Bill. Yes, it was an event through the year or a pair of events through the year. The LLC has a high proportion of its business in Brazil. Brazil had a terrible drought last year and also had a falling currency compared to the U.S. dollar. What that resulted in is temporary oversupply to the Brazilian customers. And in Q4, they normalized their inventories for the year, and that was where the slowdown happened. As I said in my remarks, the rebound has been substantial, and the margin is expected to be similar in 2022 as it was in 2021; 2021 was an aberrant year for the LLC.

Okay. All right. Great. You mentioned on the margins, it’s starting to improve in the first quarter. And do you expect them by the end of the year, you’ll be back to kind of your normal margin levels with passing costs on and everything?

I think it will be earlier than the end of the year. I think it will be by the middle of the year.

Okay. With Lygos, I know last call you had said that you expected some samples in the first quarter of this year. Did you get that? Or what’s the update on getting test samples?

The samples have been delayed to the second quarter, but we’re still expecting them. And it’s not a technical problem; it’s a test for some size, and it's difficult for them to send it out to contractors.

All right. I know you typically don’t like talking about customers, but since it’s in the filing, I’m going to ask anyways. One of your customers is customer A, which I think was an oil customer, was down quite a bit on revenue. Is there any chance that will come back? And then you had another one that jumped from $1.5 million to $4 million in sales. Is that repeatable?

I’m not going to specify which businesses these groups are in, but the one that was down is rebounding. And we see it both rebounding and growing for the 2022 year. The second one you pointed out that had a very large increase is repeatable, and we are working to put in place a supply contract with that customer that will cause it to continue to increase.

Okay. Great, great. In the past, you’ve talked about equipment you put into Peru for a new line of business, and you kept it very vague. Can you give an update on how that’s going?

Yes. Absolutely. We’re quite proud of it. Some of our products require spray drying before they can be sold fully to the customer. And in the past, we have had our spray drying done by contract. We bought the machine and we have activated it. We’re using it for all our internal spray drying requirements now, several million pounds a year. This has dropped our costs. It has increased our flexibility, and it has saved us the hassle of finding about 80 trucks a year in Illinois, which is an enormous reduction in our operations. Now the capacity of the equipment is much more than what we’re using it for. And this is actually one of the reasons for the margin compression in Q4 on top of price increases that didn’t get pushed through. We have one more step and had our whole factory approved as a GMP facility with manufacturing practices. We’re waiting for the inspectors to come and confirm that, which will also give us great approvals. We intend to use this particular spray drying machine for high-value, high-margin spraying of products. So this is an expanding field that we needed to be in for our current products, but we’re now finding that it has some high-profit opportunities for the excess capacity. We don’t have significant full contracts yet, but we’re expecting them in the second half.

Okay. Great, great. And then any plans on resuming the dividend?

The Board is reviewing that regularly. We like the idea of a dividend. We are still concerned with things like what happened this week with Shanghai being shut down. We have several truckloads of raw materials trapped at Shanghai port that won’t get loaded until the city opens up again. And then, of course, there’s the situation in Ukraine. We are watching. I don’t think things are stable enough at this point. But when they may become stable, we’ll go in that direction.

And our next question will come from an unidentified analyst.

First of all, I want to ask you about Lygos. You said you made an equity investment. Is that into a special-purpose entity with Lygos? Or is that in Lygos itself, whereby you’d benefit from Lygos’ other activities?

Thanks, Greg. It is a full equity investment in the eventual shares of Lygos. It’s in the form of a safe. But yes, we would share in the success of Lygos as a whole.

Okay. And do you own more than 10% of Lygos at this point?

We do not. The valuation of the safe values Lygos from a low of $100 million to a high of $150 million. We don’t know which of those numbers will be applied to our shareholding, the actual share.

Okay. That’s a pretty big range. And then what is Lygos doing to protect its intellectual property? And what’s your attitude towards patents in general versus just expertise and manufacturing and things that are not patented?

Lygos actually maintains an exceptionally high-quality patent lawyer on staff, and they are extremely diligent in making sure that everything they do is well covered. I approve of what they’re doing wholeheartedly because they are at the absolute cutting edge of using cell modification technology to produce organic acids. Organic acids are an enormously large part of our economy, everything from malic acid to fumaric acid for bread and aspartic acid; it goes on and on. My understanding of their technology is that it is a seminal platform technology that will eventually allow all organic assets to be produced using plant-based sources. Patenting that at the beginning is a wonderful strategy. For a company like Flexible Solutions, where our seminal technology was developed in the ‘90s and all the seminal patents have worn out, we rely much more on trade secrets and our engineering expertise and, of course, our installed plant as protection from competition. However, I will say, we’ve been making strides in the areas of nitrogen protection or nitrogen loss protection for agriculture. We are filing provisional patents in several areas that we think are brand new, and we’re publishing the patents. We’ll protect the entire field rather than simply teaching competitors where we have been and where they should go.

Okay. Good. And then another thing about that product that you have, that silicon product to prevent humification in farm ponds. Can you just explain what it is and how it works and what its potential is and how you’re going to go to market with it?

Yes. This is an ENP product, and to explain it in simple terms. In every body of natural water, you have regular algae and diatoms. Diatoms produce oxygen, and that’s very valuable to the fish. Algae, which also produce oxygen, tend to reduce light transmission. There needs to be a balance between these two species in order to have a healthy body of water that remains clear, oxygen-rich and enjoyable for swimming, let’s say. Diatoms are often limited in their growth by dissolved silica in the water. That silica is what they use to make their shells. If they can’t make shells, they can’t grow, and the algae win the competition, causing the water to turn green or, in some cases, blue or blue-green. The silica-based product invented by ENP allows diatoms to compete properly and results in a good algae-diatom balance, leading to clear, clean, and non-poisonous lake water or pond water for golf courses or farms. This is an economic way of achieving it. As to going to market, it’s already on the market. It has already generated a few hundred thousand dollars in sales in the Southeast, and we’re using select employees to bring it to other areas so that we’re controlling the message as well as possible. Just like all things, there’s no magic solution; it has to be used correctly, and you need to bring your sales staff to do a bit of extra testing to ensure its effectiveness.

Our next question will come from an unidentified analyst.

Many of my questions have been answered, particularly regarding the Lygos relationship, which is a significant part of your operations. I have a general question about the challenges you mentioned. It seems that many of these challenges are similar to those faced by your competitors. Could you provide insight into which headwinds are unique to your company? Additionally, what are some challenges related to COVID and others that are likely affecting all companies in your industry? On a positive note, are there any tailwinds you anticipate heading into 2022?

An interesting question. The challenges we are encountering include shipping, rising chemical costs, and general inflation. As we have always found, it's quite difficult to increase prices. In this current situation, we discovered that while raising prices isn't simple, it was accepted. Therefore, what seems like a challenge might actually be neutral or even beneficial in that regard. However, the overall disruption in global shipping affects companies differently; for instance, paying $15,000 for a container from Asia to Chicago instead of $3,500 last year significantly impacts a business whose typical goods in the container are valued around $50,000. This represents a substantial increase in its cost of goods. Conversely, if a container holds $1 million worth of product, the difference is minimal. We're in the $50,000 range for the value of our products in containers, making it significant for us. Our competitors are in a similar position, so it balances out. One positive aspect I'd like to point out is that it appears crop prices, fertilizer prices, and overall agricultural input costs are likely to stay high for an extended period. This trend will allow us to attract new customers and familiarize them with our conservation yield enhancement products, especially when the market conditions are favorable. For example, when urea costs $1,000 per ton rather than $300 or $400, spending $50 per ton for protection from loss becomes an easier proposition. Similarly, with soybean prices at $14 or $16 per bushel, and corn prices around $10 or $9, it facilitates making a sale. For example, we can demonstrate that we can provide an extra 10 bushels for $20. These are the positive trends we anticipate benefiting from in the agricultural sector.

Our next question will come again from an unidentified analyst.

Dan, concerning the management team at the company, I was just wondering how hard it is to execute your business plan in terms of whether you need a Chief Operating Officer or more salespeople or people in investment banking to help you with acquisitions. I was just wondering if you could talk about what you think the overall strategy of the company is or should be and how your current talent coincides with that strategy.

Well, I could talk for a couple of hours, but I’ll try to keep it brief. First thing we did—I think I said this before in speeches—acquiring ENP wasn’t just about the revenue and the synergies between the companies. It was a very calculated decision to bring George Murray, the CEO of ENP, into Flexible Solutions. Mr. Murray is going to be promoted to Chief Operating Officer for the company while continuing to serve as CEO of ENP over the next 3 to 6 months. Obviously, this will require backfilling in various positions, but we intend to do so in areas that will enable our best people to become more efficient. One of the key insights we’ve gathered about our businesses, whether it’s oil or agriculture, is that the relationships between the selling team and the buying team must be extremely high level and very deep. Myself, George, Jason Bloom, Grace Fan, Joe Fan, and of course, two more people in the ag industry, Bob and Jason Kerbs, possess those relationships. They can pass them on over an extended period of time, and we intend to do those things. Someone mentioned a customer that grew from $4 million to $1.75 million; that was due to relationship building attributable to George and me working together. When it expands to $6 million or $8 million, it will again be managed through relationship management. The new customers we expect to onboard over the next several years will also follow a similar approach. Thus, helping us to become better and making George better will be our first backfilling process. About a year from now, we might consider adding a new layer, potentially through acquisitions, which we’re very interested in, but we don’t want to introduce more complexity for ourselves. We know we need to backfill first and then grow. We can foresee a forward plan that supports us in growing as quickly as we are now or even faster, as I mentioned, while improving efficiency.

And there are currently no further questions in the queue at this time.

Chelsea, can I ask you to close the meeting? And before you do so, everyone who joined us today, thank you very much. This is the time of the year when I’ll be speaking to you again in 6 weeks. We’ll have a productive 6 weeks, and we’ll talk again soon.

Thank you, sir. Ladies and gentlemen, this does conclude today’s program, and we thank you for your participation. You may disconnect at any time.